Should a bank that does not earn its cost of capital be buying rivals? The answer to this appears self-evident, yet Commerzbank is forging ahead regardless. The German bank is close to acquiring control of Eurohypo, Europe’s largest commercial mortgage lender, for about €4.5bn.
The strategic merits are unclear. Only three years ago, after all, Commerzbank, Dresdner Bank and Deutsche Bank pooled their commercial mortgage arms to create an independent Eurohypo. There is little overlap between this specialist business of financing offices, shops and German communal budgets and Commerzbank’s mainstream retail and small business customers.
Where the deal may add value is in its financing. The estimated price of 1.1 times book value looks fair, given that Eurohypo is making a return on equity of 9-10 per cent and has a cost of equity of 8-9 per cent. Furthermore, Commerzbank is likely to finance the purchase through a mix of new shares, crystallising unrealised capital gains, and hybrid debt. The roughly €1.5bn of available capital gains are effectively “free” capital, because they are already part of the bank’s shareholders’ equity but currently do not count towards its Tier One capital. Once crystallised, they will. The hybrid debt, meanwhile, is cheap funding, costing about 5 per cent.
Financial engineering may help the numbers stack up. However, leveraging up to do a buyback would have achieved much the same thing. That Commerzbank opted for an acquisition suggests one of its real motives is to bulk up in order to avoid being taken over itself.
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